HUM - Humana: Failed Merger And Other Reasons To Buy

2023-12-11 09:15:40 ET

Summary

• The proposed merger between Cigna and Humana being called off is expected to result in a relief rally for both stocks.
• Walmart is speculated to be interested in acquiring Humana, which could lead to a higher offer and less regulatory scrutiny than the previous merger proposal.
• Humana is a fundamentally strong business with consistent revenue growth, investor-friendly practices, and a reasonably priced stock.

Usually, when a merger is announced, the stock of the acquirer goes down while the stock of the acquiree goes up. This is because the market likely believes the company being acquired is attractive enough to attract potential buyers, and the acquiree is unlikely to fold for a price lower than the market price. At the same time, the market is worried that the acquirer is likely to shell out premium cash (many times in the form of debt) to acquire a company that is not strong enough to survive on its own.

However, the proposed (and now, in danger) merger between the Cigna Group (CI) and Humana Inc. (HUM) has been a slightly different animal as both stocks have lost ground since the idea was floated. Hence, the news that the two companies have reportedly called off their proposed merger should act as a positive catalyst for both stocks tomorrow. I am presenting 5 reasons below why Humana is looking attractive here. Let us get into the details.

Relief Rally

With the proposed merger reportedly called off, it makes sense that both Cigna and Humana stock go up, since both did not take kindly to the merger proposal. I especially expect Humana to get more traction here on because the deal was reportedly called off primarily due to financial disagreements. This clearly suggests Humana values itself favorably, and the market is likely to reward their self-confidence (for not folding cheap) with a relief rally. As shown in the chart below, Humana stock was trading close to $500 before the news broke out and now finds itself almost 10% below that mark. I won't be surprised if the stock retraces those losses and then some this week.

The Walmart Factor

Walmart Inc. (WMT) is also speculated to be interested in Humana as reported here by Seeking Alpha. With Cigna reportedly walking away, Walmart may come in with a slightly higher offer to buy out Humana. After all, Walmart is almost 6 times as big as Cigna and has been exploring ways to expand its healthcare footprint. Walmart Health is set to launch in new states in 2024 with almost 30 new clinics expected to be opened. What better way to expand than to acquire the fifth-largest health insurance provider in the country, especially right after it walked away from a merger?

In addition, since a Walmart-Humana deal will not reduce the number of players in the health insurance market, it is likely to attract much lesser regulatory scrutiny than the Cigna-Humana proposal already gathered in about three weeks. Regulators tend to have additional concerns over deals that reduce the number of options in the market for consumers.

Fundamentally Strong Business

As referenced above, Humana is a strong business, mergers or otherwise. As the fifth-largest health insurance company in the country, Humana is both well established already and also has more runway ahead of it as it tries to take market share from the 4 players above it. UnitedHealth Group Incorporated ( UNH ), for example, has a market capitalization of more than 8 times that of Humana.

In a confirmation that the company is firing on all cylinders, Humana has now reported three consecutive quarters with revenue of about $25 billion and is expected to make it four in a row when it reports its Q4 numbers next month ( expected revenue of $25.60 billion). Medicare Advantage membership is on track to report nearly 20% YoY growth. Humana's net debt of about $3 billion does not cause any alarm either considering its $60 billion market cap. In short, the company is doing mighty well for itself.

The company is also investor-friendly as it not only pays a small dividend (with plenty of room for increases with a 12% payout ratio) but also repurchases its shares. Over the last five years, Humana has reduced its outstanding shares count by about 10%.

Reasonably Priced Stock

• Humana stock is trading at a forward multiple of 17 based on the expected FY 2023 EPS of $28.27. When you factor in the expected earnings growth rate of ~14%/yr over the next five years, the stock is trading at an attractive price-earnings/growth [PEG] of 1.21.
  • The average PEG for the 7 companies with PEG in Seeking Alpha's data for the managed healthcare industry is 1.38. Humana's PEG compares favorably against peers like UNH and Progyny, Inc. ( PGNY ) while lagging behind Elevance Health, Inc. ( ELV ) and Centene Corporation ( CNC ).
  • The difference between the PEG I got (1.21) and Seeking Alpha's data is due to the difference in the assumed earnings growth rate.
• The 19 analysts covering Humana stock offer a median price target of $585, a hefty 21% away from the current market price. It is interesting to note that even the most bearish price target is nearly 10% away at $525.
• The stock is trading bang in the middle of its 52-week range of $423 to $541. This is not a fundamental reason to buy any stock, but for those who don't like to chase nor like to buy a falling knife, this offers a nice middle ground.

Technical Reason

Given the recent weakness in the stock (lost 10% while the market ripped higher), it is not surprising to see a Relative Strength Index [RSI] of 35.86. It won't be surprising to see the stock reverse direction here from its oversold levels if the merger is indeed called off. Despite the weak looking RSI, the stock is only about 1% off from its 100- and 200-Day moving averages, which once again tells me the odds of a reversal are fairly high if the market perceives the merger news as positive, as is logical to expect.

Risks and Conclusion

So, there you have five reasons why I believe Humana stock is a buy here. In the short to medium term, the merger (or lack of one) is likely to dictate the direction of the stock price but over the long term, this is a strong company in a sweet spot where it is established enough but also has room to grow. But this is not to say the stock does not have any risks. For example, Humana is prone to erratic Free Cash Flow [FCF] as shown below, with especially the December quarter (current) historically being the worst. This is likely due to the nature of the industry, where the end of the calendar year results in more claims being made for the year. Other risks for Humana include the ongoing lawsuit against Medicare clawbacks and the fact that higher-than-expected medical utilization among Medicare Advantage members will hurt the company.

To close the article on a positive note, Humana's stock seems to have a bit of everything for investors. The company has already increased its dividends six consecutive years, and I fully expect the company to continue rewarding investors with double-digit dividend increases well into the future. With buybacks, dividends, and an established business, Humana stock seems to have it all for investors.

For further details see: